Perspectives on where our world is heading from a vantage point in Denver, Colorado.

14 November 2005

Unpaid Taxes.

The IRS estimates that 83-85% of taxes due each year are actually paid, a gap of about $257-$298 billion in taxes (net of amounts which will be eventually collected) in 2001. The tax gap does not impact all kinds of income equally, however.

About 99.1% of wage and salary income (which is reported on W-2s and subject to withholding) is reported. About 95.8% of income from dividends, interest, unemployment compensation, pensions and annuities (all of which is governed by comprehensive 1099 reporting) is reported. Reporting is about 92.9% correct for income from alimony, partnerships, S-corporations and capital gains, and for correct exemptions, deductions and credits on tax returns. Only about 68.2% of income from sole proprietorships, farms, rents and royalties is reported.

About 10% of unpaid taxes come from people who report their income and don't pay the amount due (about $30 billion a year), about 10% comes from people who simply don't file tax returns at all (another $30 billion a year -- primarily individuals), and the rest comes from taxpayers that underreport their income (about 60% due to lost individual income taxes, about 12% due to lost corporate income taxes, and most of the rest due to lost FICA and self-employment taxes).

The $150-$187 billion of unreported income from individual income taxes breaks down as: $83-$99 billion from self-employed business owners; $42-$57 billion from non-business income (wages, rents, royalties, interest, capital gains, etc.); $14-$16 billion in excessive deductions and exemptions; and $11-14 billion in overstated tax credits.

Employment tax underpayments come $51-$56 billion from self-exmployed people who owe self-employment taxes, and $14 billion from FICA taxes due from employers.

Simply put, self-employed business people take five finger discounts from the public purse to the tune of $134-$155 billion a year, and that doesn't even include aggresive use of legal methods to avoid reporting income. The average self-employed person in the United States lies sufficiently to reduce their tax bill by about $800 a month. Moreover, the vast majority of unpaid non-business income taxes come from the investor class and not workers.

This happens despite very favorable capital gains tax rates and deferral rules, unreasonably large depreciation deductions (compared to the true useful lives of the property depreciated) and other business tax breaks. The notion that the self-employed are overtaxed is a myth.

It is wage and salary earners who pay the highest tax rates, by far, and who pay it exceedingly reliably.